IDEAS home Printed from
   My bibliography  Save this article

Hedging in the Possible Presence of Unspanned Stochastic Volatility: Evidence from Swaption Markets


  • Rong Fan

    (Gifford Fong Associates)

  • Anurag Gupta

    (Weatherhead School of Management, Case Western Reserve University)

  • Peter Ritchken

    (Weatherhead School of Management, Case Western Reserve University)


This paper examines whether higher order multifactor models, with state variables linked "solely" to underlying LIBOR-swap rates, are by themselves capable of explaining and hedging interest rate derivatives, or whether models explicitly exhibiting features such as unspanned stochastic volatility are necessary. Our research shows that swaptions and even swaption straddles can be well hedged with LIBOR bonds alone. We examine the potential benefits of looking outside the LIBOR market for factors that might impact swaption prices without impacting swap rates, and find them to be minor, indicating that the swaption market is well integrated with the LIBOR-swap market. Copyright (c) 2003 by the American Finance Association.

Suggested Citation

  • Rong Fan & Anurag Gupta & Peter Ritchken, 2003. "Hedging in the Possible Presence of Unspanned Stochastic Volatility: Evidence from Swaption Markets," Journal of Finance, American Finance Association, vol. 58(5), pages 2219-2248, October.
  • Handle: RePEc:bla:jfinan:v:58:y:2003:i:5:p:2219-2248

    Download full text from publisher

    File URL:
    File Function: link to full text
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    1. Brock, William A & LeBaron, Blake D, 1996. "A Dynamic Structural Model for Stock Return Volatility and Trading Volume," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 94-110, February.
    2. Duffie, Darrell, et al, 1994. "Stationary Markov Equilibria," Econometrica, Econometric Society, vol. 62(4), pages 745-781, July.
    3. Judd, Kenneth L. & Kubler, Felix & Schmedders, Karl, 2000. "Computing equilibria in infinite-horizon finance economies: The case of one asset," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 1047-1078, June.
    4. Magill, Michael J. P. & Shafer, Wayne J., 1990. "Characterisation of generically complete real asset structures," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 167-194.
    5. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    6. K. J. Arrow, 1964. "The Role of Securities in the Optimal Allocation of Risk-bearing," Review of Economic Studies, Oxford University Press, vol. 31(2), pages 91-96.
    7. Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-168, February.
    8. Bewley, Truman F., 1972. "Existence of equilibria in economies with infinitely many commodities," Journal of Economic Theory, Elsevier, vol. 4(3), pages 514-540, June.
    Full references (including those not matched with items on IDEAS)

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jfinan:v:58:y:2003:i:5:p:2219-2248. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley-Blackwell Digital Licensing) or (Christopher F. Baum). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.